Federal Information Processing Standard (FIPS)-compliant systems bar use of MD5 hash algorithms.
Password Sync will fail with the following exception (logged in the event log) in a FIPS enabled environment:

To fix the exception, Password Sync can be enabled in a FIPS compliant system by locally disabling FIPS for the Directory Sync process.
This can be done by adding the following to the miiserver.exe.config file:<enforceFIPSPolicy enabled="false" />
The miiserver.exe.config can be found at: %ProgramFiles%\Windows Azure Active Directory Sync\SYNCBUS\Synchronization Service\Bin\miiserver.exe.config.